Over the last six months, I gradually reached the point where I forswore further commentary on monetary policy. Yes, I do admit that part of my difficulty with the way the central bank has gone about its work is ideological. A partisan of market solutions (except in those instances, plenty, truth to tell, when this is demonstrably inadequate for the problem at hand), I have seen the apex bank work so hard to give the forces of demand and supply a bad name. My preferred example? Look no further than the so-called “flexible exchange rate market”.
I had thought that the whole point of freeing the market was to let both the groundswell of demand for dollar-denominated assets and the massive shortfall in supply from official sources operate to give us a new market-based rate for clearing exchanges between the naira and the dollar. And, that way to have the new equilibrium price function as a signal for generating new sources of dollar input into the economy.
Incidentally, there is anecdotal evidence that this mechanism did indeed work, to some extent. First a highly valued domestic currency (unsupported by much domestic activity besides crude oil export) duly lost much of its value against other traded currencies. But no less important, Bloomberg reports that “Foreign investment in Nigerian stocks and bonds more than doubled in the third quarter from the previous three months. However, at $920 million, it was still down 8.8 percent from a year earlier and less than one-fifth of the level it reached in the third quarter of 2014.” So, we did have new sources of money come in because of the new exchange rate regime.
However, the way the market has been allowed to operate, it would seem to be the case that the apex bank looked to a specific clearing rate for the naira when it decided on freeing the interbank foreign exchange market. On the central bank’s side is a large consensus amongst many Nigerians that no country leaves its exchange rate entirely to market forces — especially when most Nigerians imagine a conspiracy against the country by shadowy forces in the West. Thus, this contradiction between the market and fixed rates is one most Nigerians are comfortable with.
None of this is bad, yet. Awful, though, is when, on the back of these arguments, monetary policy then becomes like an act of God, “surpassing all human understanding”! The point I make here is not about questions around the goal that those currently managing our economy have appointed for monetary policy. That is clear: a strong naira, despite (or even maybe because of) the negative wishes of “enemies” of this economy.
My dilemma is with the tools and instruments that the monetary authorities are minded to use in achieving this goal.
Much mirth was recently afforded me by the attempt to turn the challenge of structuring proper incentives for the functioning of the domestic markets for foreign exchange into a law and order problem. This option was always going to drive marginal operations in the market back into the shadows, not stop them. And there is strong evidence that this has already happened. The point to be made on the back of this is that the introduction of higher risk elements into any transaction invariably shows up in higher prices.
Thus, the apex bank’s operation may have made the monetary policy environment riskier, when our best hope was to have de-risked it. Still, elevated risks at the foreign exchange market pale in comparison to a new source of risk that my attention was drawn to only recently. It would seem that over the 12 months since the beginning of the fourth quarter of 2015, the Central Bank of Nigeria (CBN) may have pumped enough money into the economy to have driven up domestic money supply precipitously.
I have seen this spike in money supply plotted in graphs that also depict the trajectory of domestic prices and the naira’s exchange rate. The truth is that the correlation between the former and both these other indices is uncanny. “Correlation is not causation”. But even the slightest possibility that the CBN may have contributed to driving up domestic prices is frightening. If the new monies pumped into the economy have not driven increases in output or productivity, did they simply run after the dollar, pushing up domestic prices in the process? If the answer to this question is a “yes”, the danger is that our double-digit inflation may not be the result only of structural problems in the economy. But is instead largely caused by new money sloshing around the economy.
This is one possibility that we ought not to ignore, because it is one consequence of what a friend of mine describes as the “fiscalisation of monetary policy”.